Retirement savings - first steps

With your first pay-slip comes the question of what to do about savings. But income may also go hand-in-hand with debt: perhaps you have a student loan or some credit-card debt or hire purchase. How should you balance spending, paying-off debt and saving?

Budgeting

Though many dread it, setting a budget is the backbone of money management. Maybe it's easier to call it a "money plan" or "spending plan" – but whatever the label, it’ll help you to set and achieve long-term financial goals.

All budget advice follows the same basic idea: write down your income … and your expenses. Once you've removed your "fixed" expenses (rent, bills and commuting), you plug in the “flexible” ones (food, entertainment and clothing). You can then calculate what you’re paying each month and work out your savings. See our case studies below for how this can work.

Debt

Not all debt is "bad". Some borrowing allows us to achieve goals that would be unobtainable with savings alone, like buying a house or getting a degree. But there's also the other kind: high-interest borrowing for unnecessary stuff (what the Sorted website calls "dumb debt"). The trick is to be smart with your debt when starting out.

Student loans

The median balance across all student loans is $12,849 – so this may be your most significant debt when you start working. Once your income reaches a “threshold” of $367 per week ($19,084 a year) before tax, you have to start repaying your student loan. Repayments are 12 percent of any income above the threshold. Your employer deducts the amount from your salary or wages each time you’re paid and passes it on to the government. You can also make extra one-off repayments if you want.

Interest isn’t charged on your loan as long as you stay in New Zealand. But if you move overseas, your loan starts accruing interest after 6 months (the interest rate as at November 2012 was 6.4 percent). You can apply for a repayment holiday for up to a year, but the interest will continue and so your debt will increase. You can keep making repayments even on a repayment holiday to keep on top of your loan.

When you’re overseas, you need to make repayments twice a year, on 31 March and 30 September. What you have to pay depends on your loan balance: if it’s $1000 or less, you have to pay all of it during the year; up to $15,000, you have to pay $1000; from over $15,000 to $30,000 requires a $2000 payment; over $30,000 and you must pay $3000. These are minimum repayments only, based on the size of your loan – they may not be enough to cover your interest charge.

You can run but you can’t hide

At the end of 2012, 53,000 people overseas with student loans owed over $409 million in overdue payments. But IRD is getting tougher: it’s looking at using debt collectors to collect payments from borrowers who are overseas. And the government now has the power to recall loans from non-compliant borrowers – which means you have to pay up immediately or it’ll take legal action.

Credit cards

The convenience of a credit card often comes at the cost of high interest rates. According to Reserve Bank figures the average interest rate on credit cards is 17.8 percent. If you don't pay your monthly balance, then interest is added to the amount owing each month. But if you’re disciplined, a credit card can be a useful financial tool: paying your balance off each month gives you the benefits – an interest-free period on purchases and rewards schemes – without the downside.

However, a debit card may be a better option at this stage. It offers some of the same features as a credit card (such as being able to buy online) without the risk of running up debt.

Loans and hire purchase

These are another way of financing big-ticket purchases such as cars, furniture or appliances. Loans and hire purchase accrue interest, plus fees for arranging the loan. Look at cheaper alternatives such as lay-by or saving up the full purchase price.

If you decide on a personal loan, check the interest rates and fees. Credit unions and banks usually have the lowest rates. Stay away from finance companies and payday lenders – the interest rates and fees are usually far too high.

Hire purchase fees and interest rates vary. Make sure you understand how much you’ll be paying and for how long. Interest-free periods are great if you pay off your item in time. But some lenders may not make it clear how much you need to pay in each instalment to achieve this – and if you don’t, you’ll then be charged interest.

Retirement savings schemes

Retirement seems like a distant country when you’re starting work. But think about it this way: it’s like a holiday that could last 30 years or more. Will you be able to afford this holiday?

In a recent survey by the Financial Services Council, people estimated that the average income they'd need for a comfortable retirement was $300 a week more than what they’d receive from New Zealand Superannuation.

The earlier you start saving, the less you have to put aside to build a nest egg big enough to finance that extra $300 a week. Start in your twenties and it's 10 percent of your income; by your thirties, it's 20 percent. If you leave it till your fifties you'll need to save 50 percent.

So saving is important. But what's the most effective way to do it?

Savings accounts

These are low-risk investments: you save money regularly and don’t withdraw it … and compound interest does the rest. But they offer comparatively low interest rates: in October 2012, rates for banks’ savings accounts ranged from 0.25 percent to 4.6 percent. But even at this comparatively low rate, if you save consistently from your first pay you’ll amass an impressive amount by retirement.

You can see from our “Compound interest” table below that if a saver puts in $1000 every year for 40 years at an interest rate of 3.74 percent after tax (compounding annually), what they’ve paid in more than doubles during that period.

Compound interest

Year

Balance ($)

1

1037.40

5

5589.80

10

12,306.00

15

20,375.70

20

30,071.60

25

41,721.40

30

55,718.90

35

72,537.20

40

92,744.70

Another option is a retirement savings scheme. Most savings schemes invest your money more actively than savings accounts, and so are likelier to give you a higher long-term return.

KiwiSaver

This savings scheme is open to virtually all New Zealanders. If you are an employee, you contribute a regular percentage from your wages. Your employer contributes an equal amount, although your employer's contribution is taxed. (From April 2013 all employers have to contribute a minimum of 3 percent.) The government also gives tax credits each year.

New employees are enrolled automatically and have 8 weeks to decide to opt out of the scheme. If you don't opt out before the 8 weeks is up, you’re locked into the scheme until retirement. But after a year you can take a contributions holiday (anything from 3 months to 5 years) and renew that as often as you want or need.

We think most people should join KiwiSaver as their minimum retirement savings scheme. For some people it can also be used to help buy their first house if they meet the eligibility criteria (see www.hznc.co.nz). KiwiSaver is also good for people who aren’t employed. You still receive the tax credits. It’s best to contribute up to $1043 a year, to receive the maximum tax credit.

If you or your employer doesn't choose a KiwiSaver provider, you're automatically allocated to a conservative fund option. Some providers advocate "life stages" funds that are growth-oriented when you’re younger and more conservative later in life. But take care if you are planning to use your KiwiSaver savings to buy a first home. In that case you have a shorter investment period, and it's better to invest conservatively even when young.

You can decide for yourself what kind of fund you'd like to invest in. It's also easy to switch providers if you think another will offer you a better deal.

Other workplace savings schemes

Some employers offer their own retirement schemes as an incentive to retain staff. Most of these (as well as KiwiSaver) are what’s called a defined contribution scheme: you and your employer decide on a regular contribution amount and what you receive at retirement depends on the length and size of these contributions and your investment earnings on them.

Here are two key things to check before joining a workplace savings scheme:

The rules for withdrawing from the scheme. Some don't let you take out the funds until retirement; others may let you do it earlier (for instance, because of financial hardship).

The scheme’s portability. Workplace schemes are usually specific to one employer – you can't transfer it if you leave (although the money you've already accumulated remains yours and may be paid out to you upon leaving). Young workers often have up to 6 jobs in their first 10 years of working, so don't join a workplace scheme unless you're sure you'll stay with that employer.

Going for growth
Younger investors in KiwiSaver or similar types of investment funds are often told they should put their money into growth funds. But conservative funds had more positive returns and have been more consistent over the past 5 years. Investment strategist Jonathan Eriksen believes this reflects the new economic era following the 2008 global financial crisis, and that depending on your tolerance for risk and your goals you might be better off with either a conservative or balanced fund.

However, financial commentator Mary Holm argues that over a long period a conservative investment strategy could cost you a lot of money in lower returns. The Financial Services Council agrees: it advises that long-term growth funds have historically out-performed conservative ones. However, the past is not always a good guide to the future – particularly in periods of financial and economic uncertainty like we have today.